European government bonds continued to spiral lower after another batch of robust economic data out of the area suggested that the European Central Bank will have to lift interest rates further in the coming months. Falls were steeper at the shorter end as markets began pricing in another ECB rate hike in June. Many believe the benchmark refi rate will rise to as high as 3.25 pct by year end from 2.50 pct at present. In data out this morning, a larger than expected rise in the purchasing managers' index for the euro zone services sector indicated broad based economic recovery in the area.
The services PMI rose to 58.2 in February from 57.0 in January, outstripping market expectations for a more modest rise to 57.2.
The data follows a strong rise in the manufacturing sector PMI on Wednesday and a string of other positive survey data. Yesterday, the ECB put up the cost of borrowing by a quarter point to 2.50 pct and warned of inflationary pressures alongside strengthening economic performance.
Additionally, ECB chief Jean-Claude Trichet pointed out that with the benchmark rate at 2.50 pct, monetary policy remains accommodative. "For today, the strength of the PMIs may limit the scope for any corrective bounce at the front end of the curve," said Marc Ostwald at Monument Securities.
Looking at today's data economists said the strength of the services survey suggests that the recovery, which was initially led by exports, is now broadening to the domestic side of the economy. "All areas are now showing significant growth. We can also see a strengthening in the retail sector, which is quite promising," said Uwe Angenendt of BHF-Bank.
He said the recent data flow confirms the strength of the euro zone recovery after a temporary slowdown in the fourth quarter.
Angenendt said the euro zone economy could grow by 2 pct this year after growth of 1.4 pct last year, with GDP growth likely to accelerate to at least 0.6 pct in the first quarter after the slowdown to 0.3 pct in the fourth quarter. The European Central Bank yesterday raised its 2006 growth forecast to 2.1 pct from 1.9 pct and hiked its main interest rate to 2.50 pct from 2.25 pct.
Over in the UK, gilts were dealt a blow by an unexpectedly strong service sector performance in February which will undoubtedly weigh against the case for a Bank of England rate cut in the coming months.
The Chartered Institute of Purchasing and Supply's measure of service sector performance rose to 58.9 in February from 57.0 the previous month.
The latest reading is the highest since April 2004 and beats the corresponding figure in the 12-nation single currency area.
Analysts had predicted no change in the UK PMI. A reading above 50 marks expansion.
Howard Archer at Global Insight described the release as "impressively robust".
"It will certainly boost Bank of England's confidence that the economy is improving, although much still depends on the strength of consumer spending going forward," he said. The data makes certain that the Bank of England will keep interest rates unchanged next Thursday, he added. The BoE has kept interest rates unchanged at 4.50 pct since August last year. Some analysts believe the central bank may be forced to deliver a rate reduction some time this year as overall economic growth disappoints and inflationary pressures fade away.